What should you expect on the closing day of your business? And what insights are needed for your business’s finances and legal responsibilities before closing day? Gregg Kunz discusses these topics and more in the latest two chapters of “Lucrative Exits.” Learn more about what exactly is needed before the final closing of your business’s sale, and what obligations you may have to fulfill to successfully secure the deal.
Read through the ninth and tenth chapters of his book for FREE now:
CHAPTER NINE
Legal and Financial Insights
It is incumbent that the business owner understand the magnitude of the business sale transaction. Not only may it be the most significant financial transaction of their life, but it is also a complex legal transaction to which both parties will be held accountable. Finding yourself on the receiving end of a lawsuit is disruptive and stressful at best; at worst, it can be financially devastating.
Over the years, we have seen judgments in favor of buyers in which sellers are obligated to return not only the sale proceeds but also additional monies awarded for a multitude of damages. How to protect yourself? Complete clarity and disclosure of all information provided to the buyer and the disclosure of adverse material facts. Be aware that while your broker acts in your interests, they are legally and ethically bound to disclose adverse material facts, both explicit and implied. When in doubt, discuss the issue, potential or otherwise, with your broker and the attorney representing you in the sale transaction.
Buyer and Seller Responsibilities
Consent
Business owners must have legal consent from all owners, partial or otherwise, to sell the business. This is a conversation to have with all owners of the business prior to the decision to sell. A competent broker will confirm all ownership interests with the seller, check the state website to confirm entity structure, and have all owners complete a simple consent form. The attorneys and lender will also require a similar document to be signed before closing. If a partial owner is overseas or otherwise unavailable, this can delay the closing.
Financing
It goes without saying that the buyer must obtain financing for the purchase, and the approval for financing must be obtained as far in advance of closing as possible. This is why the buyer must maintain pressure on their lender until the financing is approved. Another role of the broker is to ensure that the buyer takes all the required steps in the financing process and that deadlines are met. A buyer who does not demonstrate a sense of purpose and urgency during this phase will likely be a problem as the proposed closing date approaches.
Confidentiality
Confidentiality is critical not only in the early stages of communication between the parties but also up to and after closing. Obviously, the employees will be made aware of the change in ownership. Controlled and well-conceived communication with customers and suppliers is especially important to minimize potentially negative impacts to the business.
Operational Obligations
In transactions that include an earn-out or forgivable/contingent seller note, the buyer may be contractually obligated to operate the business in a particular manner, both financially and operationally, to ensure that these deferred monies are not put at risk. Sellers and their brokers are advised to perform a degree of due diligence on the buyer to determine that the buyer has the expertise to operate the business. Entering into an agreement with a buyer who is financially or experientially unqualified is pure folly. In our world, this is a critical part of the vetting and qualification process performed by the broker.
Seller Financing
Seller financing, in the form of a promissory note, must be taken very seriously. The buyer is not only liable for the payment but should have personally guaranteed the note. Failure to perform as agreed will not only injure the seller but can devastate the financial health and future of the buyer.
Representations and Warranties
Buyers typically are not subject to many of the “Reps and Warranties” that sellers are. Essentially, the business owner represents and warrants that the business is as presented; true, accurate, and complete. These representations and warranties typically last from as little as 6 to 24 months and usually 12 to 18 months. If, during this period, it is found that these are untrue, the seller is likely to bear both legal and financial responsibility for each breach. The amount of liability is specified within the Representations and Warranties section of the Asset Purchase Agreement (APA). Sellers should understand that breaches are serious and can be financially devastating – to the point of the entire sale being rolled back and the seller being compelled to pay back the buyer and the lender.
Covenants
Other important obligations of the seller are outlined in the Covenants section of the APA to fully abide by the non-compete agreement, employment agreement, training and transition agreement, and other agreements accompanying the APA.
Key Considerations for the Business Owner
Three other items should be brought to the attention of the business owner in consideration of the sale.
- Seller Note Standby: When a sale transaction includes seller financing, the seller should know that this note is second in line behind the lender’s loan (meaning that in the event of a default, the lender must be paid prior to the seller receiving payments on the seller note) and that payments towards the seller note may not begin until the conclusion of the standby period without authorization from the lender. Until as recently as 2023, the seller note standby periods could be as long as the duration of the SBA loan – as long as ten years! That’s an awfully long time to wait for your sale proceeds, especially if interest is not accruing.
An important note: It’s human nature for a seller and buyer to discuss beginning the early payment of the note. The buyer knows that the seller wants their money sooner, and the buyer may be inclined to minimize the accruing interest as well as being beholden to another creditor. Early in my career, when I was working to reach an agreement with the broker representing the buyer, our managing broker suggested that the easiest path would be for the parties to have a side agreement outside of the transaction – in which payments would commence three months post-closing. This seemed to be a surefire way to overcome the seller’s objection to waiting for their money. When the SBA lender inquired about the final terms of the seller note, we stated that they would enter into a side agreement. The SBA lender flatly said that this was not only in breach of the lender’s rules but also that this was a loan made under the guidelines of the federal government, that this was illegal, and she would be obliged to report the parties to the regulators. I recall the conversation clearly and was fortunate to be advised as to the seriousness of this path by the lender. We learned just how little oversight the managing broker was providing and that they were jeopardizing our future as well as theirs. Every broker needs to understand the rules and advise their clients accordingly. This is why we advise business owners to engage only with brokers active in their industry associations who have received the credentials demonstrating their ongoing commitment to education. There is no additional cost to a business owner in selecting a credentialled broker; it simply makes plain sense.
- Landlords: Landlords have little incentive to assign a lease to a new owner. The reason is straightforward: The seller has an established track record of lease payments to the landlord, and the buyer has no history with the landlord. If the seller’s lease contains a lease assignment clause, the landlord is legally obligated to assign the lease as long as the buyer has the appropriate financial strength. Many leases also have a personal guarantee from the seller, and in some cases, the seller’s personal guarantee may not be released upon assignment. As one can imagine, a seller remaining personally liable for payments by the new owner for the duration of the lease is unpalatable. New leases may be created in the absence of an assignment clause, or an assignment may be granted with the hope that the landlord will give the buyer a new lease or lease extension when the existing lease ends. In many cases, regardless of the existing lease, the buyer and landlord will draft a new lease agreement.
- Working Capital: Working capital is, without question, the most misunderstood and complex topic in the transaction process. There are many ways to determine working capital; getting two competent financial experts to agree on the methodology and amount is virtually impossible. For this reason, I will only provide a topical definition for the reader to grasp the concept and leave the experts involved in your transaction to arrive at an agreeable amount.
Working capital is the difference between the company’s current assets and current liabilities. It pays short-term debt, purchases inventory, and pays day-to-day operating expenses. These may include payroll, payroll taxes, utilities, and those expenses required to operate the business.
There are a variety of factors that impact the working capital calculation. Businesses that are seasonal or have fluctuating working capital needs from one period to another must be carefully and accurately calculated. Business sale transactions (Asset Sales) below $2,000,000 in total sale price often do not include working capital provisions. The seller exits the transaction, retaining all cash and accounts receivable, and paying off all liabilities (debt) associated with the sale. Therefore, the buyer must provide working capital from day one to meet near-term financial obligations. These funds may come from the lender as a part of the loan package in the form of a line of credit.
For transactions with a total sale price of more than $2,000,000, a buyer may include a working capital amount to be left in the business at closing. The inclusion and amount of working capital are negotiable, and competent brokers should advise the seller that the potential for working capital to be a part of the transaction is a very real possibility.
Documentation
The usual and customary legal documents associated with the business transaction include:
- NDA (Non-Disclosure Agreement)
- IOI (Indication of Interest) is typically associated with transactions over $5,000,000
- LOI (Letter of Intent)
- Asset Purchase Agreement (APA)
- Purchase Sale Agreement (PSA) – if real property is included in the overall transaction
- Bill of Sale
- Assignment and Assumption Agreement (assigning contracts)
- Assignment of Registered Intellectual Property (if applicable)
- Seller Note
- Personal Guarantee
- Security Agreement (if applicable)
- Non-Compete Agreement
- Training & Transition Agreement
- Employment or Consulting Agreement
- Offer Letters to Employees
- Bank Loan Documents
- Purchase Price Allocation Schedule (PPA): used to allocate fair value to a company’s assets and liabilities upon the sale’s completion. Items within the APA may include Equipment Assets, Inventory, Training and Transition, Leasehold Improvements, Non-Compete Agreements, Employment or Consulting Agreements, Assumed Debt, and Goodwill. It is important for the broker and business owner to confer with the business owner’s tax professional and attorney to propose the Allocation of Purchase Price. The reason is that the post-sale tax implications for both buyer and seller are typically not aligned. This discussion should happen well in advance so there is agreement before closing.
As outlined previously, business sale transactions are complex, with legal obligations impacting the seller, buyer, and lender participating in the transaction. These must be memorialized to protect the parties and meet local, state, and federal laws associated with a change of ownership. The Letter of Intent is the document that outlines the transaction and is not in and of itself the legal instrument binding the parties. The Asset Purchase Agreement (APA) contains many sections, including a complete description of the business being sold, financial consideration, representations and warranties made by the seller, and the seller’s liability should representations or warranties be violated. Additional documents, such as the Non-Compete, Consulting Agreements, Purchase Price Allocation, Seller Note, etc., are other documents executed at closing.
Tax Talk
Business brokers are prohibited from dispensing legal and tax advice associated with the sale transaction. Federal, state, and local tax laws are complex and subject to change, and the implications to each party will be unique to the parties. Tax considerations surrounding a transaction include short and long-term capital gains, installment sale taxation (associated with seller financing), depreciation recapture, and the standard income tax associated with other compensation paid to the seller. In addition, sales tax liabilities may be created on the transfer of assets at the time of sale.
I hope you are now beginning to understand the importance of meeting with a business broker well before an exit. A broker who suggests that they can advise you on any tax or legal matter is shooting from the hip at best and should be dismissed. Your tax professional should be included in the conversation to explain that in addition to the total sale price, what is most important is the net post-sale proceeds and any future tax ramifications. By adhering to the guidelines and principles outlined in this chapter, you can minimize risks, avoid common pitfalls, and maximize the benefits of their business sale. Ultimately, this journey, while complex, can lead to a rewarding outcome when navigated with knowledge, caution, and professional guidance.
KEY TAKEAWAYS
- Complete transparency and full disclosure to the buyer mitigates the risk of legal repercussions and ensures a fair and transparent transaction.
- Acquiring consent from all owners and securing financing well in advance are critical steps in the business sale process, and they demand careful planning and diligent follow-through.
- Confidentiality throughout the transaction protects the interests of all parties involved and maintains stability in the business’s operations and relationships.
- Operational obligations, particularly in deals involving earn-outs or seller financing, may require the buyer to adhere strictly to specific operational standards to protect deferred payments and ensure the business’s continued success.
- Understanding and preparing for the tax implications and legal documentation in business sales is crucial, as these elements significantly affect the transaction’s immediate and long-term financial outcomes. Letting your tax advisor and accountant know that you are planning to sell is imperative. This will provide them the insight and time needed to address specific accounting and tax preparation issues that are best served well before the sale process.
- Brokers should never offer or dispense legal or tax advice nor ever sway you from seeking such professional advice.
CHAPTER TEN
Closing Day
Finally, the big day arrives, and a somewhat unfamiliar calm washes over you as you head to the closing table. This is certainly cause for celebration, but you can expect that as celebratory as the day is, it is tempered by a strong sense of relief. In many cases, it comes as a surprise to the seller that the closing was somewhat of a non-event. Getting to the closing table is a stressful rollercoaster. In the days leading up to the close, I do my best to coach our seller clients that the last-minute requests by the buyer, lender, attorneys, and other parties associated with the transaction are normal and to be expected.
Quite honestly, the days and weeks leading to the closing are grueling and stressful, and emotions can reach a breaking point. For the seller, the smell of money, leaving behind their routine, and attaining the goal surfaces emotions that they don’t expect. For the buyer, the excitement of reaching their objective along with some underlying trepidation or fear of the unknown are natural human emotions.
Tips To Minimize Stress Before Closing
- First and foremost, the closing date should be viewed as aspirational rather than set in stone. The vast majority of transactions do not close on the date set forth in the Letter of Intent.
- Remember that many parties are associated with the transaction, each dependent on others.
- The seller and buyer are the most eager parties, except, of course, the broker. Keep in mind that for the lenders, landlords, and attorneys, your transaction is simply another day at the office and that the day’s victorious outcome will never approach the significance it has for you.
- Keep your eyes on the prize and understand that last-minute hiccups are sadly part and parcel with the sale process, no matter how ridiculous. Will you get irritated or angry? Most likely, yes. Take a breath, complete the task, and know the end is near.
- If you have engaged with the right broker, you can be assured that they have done everything possible to manage the transaction and manage the lender and attorneys to complete it. If the broker has done their job correctly, virtually everything is now out of their hands, and much like the obstetrician who arrives moments before a birth, they appear for the adulation of a successful outcome.
Remember, too, that even though the funds are now sitting in your bank account, you will be back in the office tomorrow, announcing the sale to your former employees and beginning the training and transition process. An important point: If your sale includes seller financing, you will receive a promissory note at closing. This is a negotiable instrument, and the original should be kept in your safe deposit box along with all of the closing documents. Finally, send a copy of the complete closing documents to your tax preparer, who will need them for tax filing purposes.
Do take a moment to savor the sale. You deserve it, and no one knows that more than you. Congratulations.
GREGG KUNZ
CHAPTER ELEVEN
Transitioning Leadership and Legacy
As business owners approach the finish line of selling their enterprise, they often envision the conclusion as a definitive end to their journey. However, the reality is that the closing of a sale is the beginning of a new and critical phase: the post-closing and transition period. The pressures and stress of getting to the closing table may result in a post-close, post-celebration “hangover.” The seller is relieved that the deal is done, and the buyer likely feels the excitement of ownership and the weight of what lies ahead. Where do they start? How do they announce the change of ownership to the staff that is now theirs?
Over many years, the seller established a clear and regular cadence of their workday. They prioritized and addressed their daily activities with a familiar, comfortable routine, and probably without much thought. For them, it would simply be another day at the office. For the buyer, this is entirely new territory.
In the days leading up to the closing, most of the focus has been on getting the various documents assembled and submitted to get the deal done. The seller is mentally ready to walk into the sunset to enjoy the freedom and flexibility they envisioned. In all likelihood, very little focus or planning has gone into this critical next phase. The Training and Transition agreement in the closing documents outlines the duration of the training and transition period. Still, it lacks both formality and an organized outline of all that needs to be accomplished in an orderly and logical manner.
Further compounding the challenges ahead are sellers’ and buyers’ personalities and “work styles.” If little to no planning is paid to this phase, both parties will likely become frustrated, and the rapport built during the past months will be diminished. The best way to ensure the smoothest and most effective transition period is with a plan. This plan should include a general outline with timeframes agreed to and documented by the participants.
The first step in this discussion must be to communicate the importance of having a plan and that both parties must work together for the best results. The seller is the veteran expert, and the buyer is the novice newcomer to the party. Each must understand that patience and a sense of purpose will help this process.
Training and Transition
The transition period typically begins with the change of ownership being announced to the employees. Once completed, the seller will walk the buyer through the business’s daily operations, how the product or service is sold to customers, how orders are placed with suppliers, how the accounting and business management system operates, and opening and closing procedures. Much of the education process is incumbent on the new owner to revisit the many operational processes and procedures the business has established for day-to-day operations.
The seller must understand that years or decades of experience and knowledge must be conveyed in a short yet critically important period. The buyer must know they have a short timeframe to complete the training and transition period. Depending on the buyer’s experience with the business or industry, the period may last from several weeks to several months. We typically see no cost associated with the period unless the duration is more than 30 calendar days, after which the parties may agree to an hourly, daily, or fixed rate. The initial portion of the period is usually done in person and on-site, after which phone and email support will make up the balance.
As one might expect, the ongoing presence of the prior owner can create some uneasiness or questions about who the staff should be reporting to. I have found that the new owner is ready to take charge after the first week or two, and the seller’s time commitment falls off dramatically. It goes without saying that the seller should help the buyer as much as possible for a smooth transition.
Buyers must remember that how they treat the seller during the previous sale process will likely impact them during the transition period. Antagonizing the seller during the process rather than building goodwill will diminish the transition’s effectiveness. The seller may limit their activities to only meet the requirements agreed to in the closing documents and no more. Collaboration and building trust between the parties is paramount to a good relationship post-transaction.
Only a few months ago, one of my seller clients called me two days after the closing in a state of frustration and concern. He arrived at the office ready to begin the transition, and the buyer spent the first three hours on the phone speaking with utility providers, the owner’s banker, friends, family, and their investment advisor. The buyer should understand that the training and transition period has a firm beginning and ending date and that this time must be used wisely.
Tips for Avoiding Post-Closing Challenges
- Sellers should not be expected to actively manage the business while the new owner is in training. The buyer is now fully at the helm of their new ship.
- Sellers must not forget or resent the amount of time they committed to for the training period.
- Sellers should diplomatically defer to the new owner for decision-making and staff communication.
- The seller must understand that even though the transaction has been completed, they are legally bound and responsible for providing the training and transition as outlined in the agreement.
- Remember that in the excitement leading up to the sale, each party may cheerfully agree to one arrangement only for the seller to find it a burden later or that the buyer expected more from the seller. As documented in the Training and Transition section of the closing documents, clarity of expectations is critical.
- The best way to minimize conflict and maximize the effectiveness of the transition period is to build upon the relationship fostered during the sale process.
- A wise broker will remind the parties that they will be working together after the sale is completed and will check in with each party in the following weeks to provide a quiet word to each party if and as needed.
New and Unfamiliar Roles
Sellers will likely face various emotions once they part from the business. Despite their eagerness to move on to the next phase of their lives, they may feel a general sense of loss: loss of power, identity, and control over their daily routine. However, business owners who have been able to sell on their own terms gain a newfound freedom and a great sense of accomplishment – as they should.
By the time the training and transition period ends, the sense of loss is replaced by a real sense of unencumbered freedom. In the months, weeks, and days leading up to the sale, the seller will typically have begun a mental list of all they will do once free from the daily responsibilities of operating the business. What do they do with all of this time on their hands? Virtually all of my clients have told me how quickly they find plenty to occupy their day and embrace the freedom that comes with their exit.
KEY TAKEAWAYS
- Effective post-closing transitions require a well-documented plan that considers both the seller’s and buyer’s responsibilities and expectations, focusing on a smooth and structured handover process.
- Training and transition periods should be respected and utilized wisely, with both the seller imparting their knowledge and the buyer actively engaging and taking charge of the new responsibilities.
- Post-closing challenges are inevitable but can be significantly reduced through proactive planning, understanding roles, and maintaining a good relationship built during the sale process.
- Both seller and buyer must remember the legal and ethical obligations tied to the training and transition agreement, ensuring a commitment to the success of the business and each other’s goals.
Get your copy of “Lucrative Exits” by Gregg Kunz today and start your journey towards a more rewarding future.